IEC Electronics Corp.
Q2 2018 Earnings Call Transcript

Published: 12 May 2018

[Operator:]

Greetings. And welcome to IEC Electronics Second Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Audra Gavelis, Director of Marketing and Investor Relations. Please go ahead.

[Audra Gavelis:]

Thank you for calling in. On the call this morning, we have Jeff Schlarbaum, President and CEO; as well as Michael Williams, Chief Financial Officer. Before we get started, I would like to take a moment to read the Safe Harbor statement. This conference call contains certain statements that are or may be deemed to be forward-looking statements. These forward-looking statements, such as when the company describes what it believes, expects or anticipates, will occur and other similar statements include, but are not limited to statements regarding future sales and operating results, future prospects, strategic initiatives, turnaround and growth efforts, the capabilities and capacities of business operations, any financial or other guidance, and all statements that are not based on historical facts, but rather reflect the company’s current expectations concerning future results and events. The ultimate accuracy of these forward-looking statements is dependent upon a number of risks and uncertainties that may cause the company’s actual results or performance to be different than as expressed or implied by these statements. Specific risks and uncertainties include, but are not limited to, those set forth in the company’s earnings release issued immediately before this call and in the company’s most recent Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q and our other reports filed with the Securities and Exchange Commission. The company undertakes no obligation to publicly update or correct any of the forward-looking statements made during the call, whether as a result of new information, future events or otherwise, except as required by law. I will now turn the call over to Jeff Schlarbaum. Please go ahead, Jeff.

[Jeff Schlarbaum:]

Thank you, Audra and good morning everyone. Our fiscal second quarter showed strong performance with revenue levels, enhanced margins and improved profitability when compared to the same quarter last year, as well as our fiscal 2018 first quarter results. Our year-over-year revenue growth of 49% and 50% sequential growth for fiscal 2018 second quarter can be attributed to our focused go-to-market strategy as well as our operational execution which has led to high levels of customer satisfaction and has allowed us to convert our growing backlog into revenue. As this quarter demonstrated, this top line growth has led to improved margins and bottom line performance. There are three primary factors driving the increased volumes we are experiencing. First, we have seen increased volumes from existing customers for the legacy programs we have supported. Demand from our existing customers is driven by the end markets and their manufacturing needs can fluctuate overtime. We believe IEC’s ability to be flexible and responsive is the competitive advantage that positions us as a solid manufacturing partner for programs that we can service over a long period of time. Second, we are seeing an increase in new program conversions or brand new assemblies from existing customers. Over the past couple of years, we have continued to improve our operational execution, which has resulted in our customers directing the greater share of their outsourced work to IEC. And finally, we are adding new programs from new customers. Throughout fiscal 2017, we rebuilt our sales funnel, which resulted in a strong pipeline of new opportunities. We have started to convert several new opportunities into new customers and we’ve begun the onboarding process that we believe will evolve into large scale long term programs. To provide a little more context around the progress we’re seeing attracting new customers and programs, I can provide the following color. During the first half of fiscal 2018 for example, the number of NPIs or new product introductions from our largest facility in Newark, were almost tripled when you compare that to the same period in fiscal 2017. We also believe that more than 20% of our total revenue for fiscal 2018 will be associated with new product introductions versus approximately 10% in fiscal 2017. Also, we are experiencing an almost 30% year-over-year increase for fiscal 2018 second quarter and the number of unique assemblies manufactured at our largest facility in Newark. Our success of tracking new customers and new programs is of course a positive development but it’s also important to note that the on boarding process of new products is complicated and at times it can be lengthy. Once we win a new project, we work through several steps in the process that results in customer acceptance and approval for production. During the process however, there are often customer driven changes that occur and that could add time to our original manufacturing production assumptions. So while the additional processing steps can impose slight margin pressure during its stages, we are confident and we expect that we can improve our efficiencies overtime which will lead to improved margins and higher levels of customer satisfactions. This brings me to another topic, the ongoing global supply chain component constraints. As you know in fiscal 2018, Q1 we mentioned that one of our challenges which is affecting the entire industry was associated with difficult and procuring certain electronic components, and in some cases, facing non-lead times our allocation restrictions due to limited global supplies. These shortages can impact our ability to fulfill our customer’s orders and lengthen production times as well as add some amount of unpredictability as we wait for a specific components to complete a job. At this time there are strong indications that this constraint environment will continue into the foreseeable future. So, we remain focused on working with our supply chain partners and customers to mitigate the risk. While we’ve seen an increase of inventory in fiscal 2018, primarily driven by increases in customer demand in this component constraint environment, the timing of deliveries continues to contribute to some variability in our business planning. Regardless, our sales funnel and backlog continue to be robust, and we continue on our path of driving organic growth through the balance of fiscal 2018. In fact, exiting fiscal 2018 Q2, in light of our 50% sequential revenue growth over fiscal 2018 Q1. We also experienced a greater than one to one book-to-bill ratio further demonstrating that our backlog has continued to grow. Our fiscal 2018 second quarter demonstrated great progress converting backlog to sales. We have solid existing relationships which we continue to strengthen by delivering operational institution and the flexibility to meet changing project needs. Not only has this lead to new electronic manufacturing service awards from long standing customers, it is also now producing a growing level of business for our vertical service offerings, such as our lab services, our wire and cable harness assembly and our precision metal, fabrication and machining. Our customers are increasingly looking at IEC as a one stop shop for a large percentage of their outsourced work, which we expect will lead to a higher level more strategic engagement overtime. Likewise IEC’s growing recognition as a leading provider of vertically integrated manufacturing solutions for life saving emission critical products has introduced us to new audiences and we are pleased to onboard these new strategic customers at a growing rate. With that, I will now turn the call over to Mike to review the company’s detailed financial performance. Mike?

[Michael Williams:]

Thank you, Jeff and good morning everyone. Revenue for the second quarter of fiscal 2018 was $31.8 million, an increase of 49% as compared to the second quarter of fiscal 2017 and 50% greater than the first quarter of fiscal 2018. Our conversion of backlog to sales improved this quarter as several program deliveries shifted from the first quarter to the second quarter and our overall execution improved. Looking at the three business segments in the second quarter of fiscal 2018, we saw a revenue distribution of 64% from our aerospace and defense sector, 22% from medical and 14% from industrial. The aerospace and defense sector saw a net increase of $10.8 million as compared to fiscal Q2 of 2017 primarily driven by new programs from two existing customers which contributed to $8.3 million of the growth. Another $3.1 million was related to existing customers with increased demand on existing programs. Although the medical sector increased significantly over fiscal 2018 Q1, it was only up a modest $200,000 over the second quarter of fiscal 2017. The year-over-year increase was related to increased revenue of approximately $1.1 million from one customer whose demand had previously been on hold for over a year. This increase was partially offset by decreases in demand from other customers. We expect the medical sector to remain roughly 20% of our revenue next quarter, but will start to increase as a percentage of our total revenue as several customers ramp up their demand. The industrial sector decline of $600,000 was primarily due to decreased demand from multiple customers whose end markets had softened, partially offset by modest increases in demand from other customers. Gross profit for the second quarter of fiscal 2018 was $4.8 million or 15.1% of sales compared to $2.3 million or 10.7% of sales in the second quarter of fiscal 2017. The margin improvement was driven mainly by the increased revenue, leveraging our overhead and better utilizing labor. Selling and administrative expense increased $300,000 and represented 9.2% of sales in the second quarter, compared to 12.5% of sales in the same quarter of the prior fiscal year. The increase in expense is primarily due to higher wage and related expenses. The company recorded a net income of $1.6 million in the second quarter of fiscal 2018 or $0.15 per share, compared to a net loss of $615,000 or a loss of $0.06 per share in the second quarter of fiscal 2017. Now looking at the results for the first six months of 2018, revenue increased 25% to $52.9 million compared to $42.3 million in the prior fiscal period. Growth was primarily driven by an increase in sales in aerospace and defense sector of $13.3 million, partially offset by decreases of $2 million and $700,000 in the medical and industrial sectors respectively. The growth was almost all in our fiscal Q2, 2018 results as fiscal Q1, 2018 was relatively flat to prior fiscal year. Gross profit increased $2.2 million from 9.6% of sales in the first half of fiscal 2017 to 11.9% of sales in the first half of fiscal 2018, directly related to the increase in revenue. Selling and administrative expense increased to $5.7 million and represented 10.8% of sales in the first six months of fiscal 2018, compared to $5.1 million or 12% of sales in the prior fiscal period. The increase in expenses was primarily due to higher wage and related expenses of $500,000. Net income for the first six months was $1.1 million or $0.11 per share as compared to a net loss of $1.5 million or $0.14 per share in the same prior year period. However, in fiscal Q1 of 2018 we did report a net tax benefit of approximately $1 million resulting from the release of the valuation allowance and our alternative minimum tax credit as a result of the December 2017 U.S. Tax Cuts & Jobs Act. Now turning over to our balance sheet. We continue to focus on our cash conversion cycle. Inventory at March 30, 2018 was $21 million compared to $15.6 million at September 30, 2017, but was roughly flat to the $20.9 million in inventory we reported as of the end of fiscal Q1, 2018. This improvement was directly related to our improved conversion of backlog as previously mentioned. But it’s important to note that the industry wide supply constraint is challenging our ability to manage on hand inventory. Additionally, we reported $1.3 million in assets held for sale as the company entered into a $2 million purchase and sale agreement for the Rochester facility in fiscal Q3. As part of the transaction, the company will enter into a 15-year lease agreement, part of the proceeds from the transaction will be used to pay off the Celmet Building Term Loan of $700,000 which matures later this year and the remainder will be applied to Term Loan B. Also on April 20, after the close of the second quarter, we entered into the fifth amendment to our fifth amended and restated credit facility agreement with M&T Bank increasing our revolving credit facility to $22 million and an effort to increase working capital flexibility to support our growth initiatives. With that, I’ll turn the call back over to Jeff.

[Jeff Schlarbaum:]

Great, thanks Mike. We’ve identified three key elements, necessary to continue our growth trajectory as you move through fiscal 2018. First, clearly focusing on our target end markets and customers. Second, driving sales conversions and third, continue operation of excellence. An estimated $40 billion in electronics product assembly is outsourced in the U.S. and approximately $18 billion of that comes from our target end markets. Our sales team continues to focus exclusively on customers and have in whole or in part a domestic outsource strategy for their complex, high reliability products and who are looking for long-term strategic partners. We believe IEC is well positioned competitively because we are exclusively U.S. based. We have a broad set of capabilities to minimize customer supply chain risks with our vertical service offering and we have the technical know how to solve complex manufacturing challenges. Throughout fiscal 2017, we’ve rebuilt our new business pipeline in terms of both business processes and execution to more importantly, which resulted in a creation of many new opportunities. We are now at the stage where new opportunities are converting to new program awards in parallel with consistently adding new prospects to our funnel of future opportunities. Finally, our operational excellence is paramount to our continued growth. In order to capture new customers and to win new programs from existing customers IEC must continue to deliver consistent execution for highly complex programs and provide customized solutions to address the ever-changing technology landscape. During the fiscal 2018 second quarter we announced a facility expansion of our Newark headquarter operation with the construction of a new state-of-the-art advanced manufacturing center. In association with his announcement we're also pleased to report that state of New York pledged $5 million in state aid the creation of over 360 local jobs over the next five years. With our current Newark facility residing in 100-year-old building, we recognize that the ability to design from the ground up a new state-of-the-art facility would be a more prudent way of offering our growing customer base unmatched capabilities for the manufacturing needs versus the capital expenditures required to modernize the current one. We are projecting the opening of the new facility to occur in the middle of 2019. Our fiscal 2018 second quarter results clearly demonstrated progress as we continue to navigate our path to growth. This is an exciting time for company and we look forward to continuing our growth momentum as we moved through the balance of fiscal 2018. With that, I will now turn the call over to questions.

[Operator:]

Thank you. At this time we will be conducting a question and answer session. [Operator Instructions]. Our first question comes from the line of Ben Klieve with Noble Capital. Please proceed with your question.

[Christian Herbosa:]

Hi. Thanks for taking my call. This is actually Christian Herbosa on for Ben. I have two questions. First, you mentioned that you're seeing ramping demand in the medical sector. So excluding the impact of your two major customers can talk about contribution of that new customers are providing?

[Jeff Schlarbaum:]

Yes. So, great question and thanks for asking. So, the fiscal Q2 volume increases we saw were largely attributed to our existing customers in the medical sector that we've serviced over the course of time. However, I can tell you that in the current quarter of Q3 we're ramping up some new medical programs that will have impact in our Q3 fiscal revenue results and we anticipate growing impact going forward. But as it related to Q2 its primarily related to our legacy customers.

[Christian Herbosa:]

Okay, great. That's good to hear. And then my second question is regarding the new aerospace and defense programs that represent the bulk of the growth this quarter. Are those programs at a full run rate in terms of revenue and margins? Or is that business still ramping?

[Jeff Schlarbaum:]

It's still latter. Some of them are legacy programs that are increase in volume. So, those margins are more predictable and more mature. There were however a number of newer programs in the revenue stream for Q2. And so those will increase in volumes over the course of time and our margins attribute to those should improve over time as well.

[Christian Herbosa:]

Okay, great. Thanks for taking my call.

[Jeff Schlarbaum:]

Absolutely. Thanks you.

[Operator:]

Our next question comes from the line of Nehal Chokshi with Maxim Group. Please proceed with your question.

[Nehal Chokshi:]

All right. Thanks. Fantastic results; and actually quite surprising in the context that this is December disappointed partially due to the golden screw problem that you had discussed. Now it sounds like that the problem is persisting because the components are still a constraint here. So from the context can you explain how you navigate through the golden screw problem in the March quarter? And then I'll probably have a follow-up.

[Jeff Schlarbaum:]

Absolutely. Thanks Nehal, good question. Yes, you're right. So, the golden screw as you referred to and certain I have in the past problem still exists. And the benefit that we had in Q2 is that in Q1 we fell short of our revenue execution, expectation because we didn't have the full kits to build the products for our customers in that period. However as we moved into the Q2 period a lot of those parts shortages were starting to clear up. So it was really a timing issue in Q1 that helped us in Q2, startup a bit stronger with fuller kits to produce for our customer which obviously increased our revenue in the period. As we look at Q3, we're experiencing some similar constraints as we have in the past, but as we get the benefit of time, those lead times that maybe in Q1 we're out several quarters. Now as we moves through time those quarters are starting to move in terms of those delivery expectations. So while we'll have the constraints ongoing, it shouldn't provide that level of disruption that we saw in Q1.

[Nehal Chokshi:]

Okay, great. You actually answer my follow-up question, but I have other questions as well. Do you expect medical verticals to increase Q-o-Q?

[Jeff Schlarbaum:]

I'm sorry, I didn't hear, Nehal?

[Nehal Chokshi:]

Do you expect the medical verticals to increase Q-o-Q for fiscal Q3, i.e. the June quarter?

[Jeff Schlarbaum:]

Yes. We do.

[Nehal Chokshi:]

You do. Okay. So then it's safe to say that you expect overall revenue to also increase Q-o-Q?

[Jeff Schlarbaum:]

Yes. We do. My only caution there is just as not fully been in our control the supply constraints that provide a bit of unpredictability, but with the backlog growth that we've seen the orders are continuing to come in and book at a very brisk pace. And so the backlog is strong. We continue to see strong demand from a diverse array of our customers. So, yes we see overalls as look towards this quarter and actually as we entering the Q4 and the balance of our fiscal 2018 we absolutely see continued growth. So that's best way, I guess to answer that question.

[Nehal Chokshi:]

Okay. Are you willing to disclose what the backlog was at the end of the March quarter or where currently is?

[Jeff Schlarbaum:]

Yes. So we're going to eventually I do think get in a position where the business matures it becomes more predictable and won't be able to project and be more transparent with the key metrics of the business. It was up. It was better than one to one. And as you know, Nehal, we had a better than 50% sequential growth. So with almost $32 million in sales and our backlog exceeding the revenue in terms of book-to-bill, we had been nice backlog increase and obviously, we're at that for now.

[Nehal Chokshi:]

Okay, great. My follow-up question is that looks like all the cash conversion cycle components trended in direction as you wanted to. And I guess my question is do you think you're now at the optimal levels for your cash conversion cycle components or is there still more work to do there?

[Jeff Schlarbaum:]

There is still some more work to do there. And we're – our inventory levels are higher than I would like them to be only because typically when we're more just in time and we have the parts all being delivered when expected from the supply chain, we can convert them into sales and then replenish with raw material received and convert those in the sales. Right now, some of the lumpiness in the deliberation of supply chain are causing me to bring on raw materials that now are just sitting in stores waiting for the proverbial golden screw and so the revenue, I mean the inventory levels are higher than I'd like them to be and we certainly have opportunity to improve them going forward.

[Nehal Chokshi:]

Okay, great. Thank you.

[Jeff Schlarbaum:]

All right. Thanks, Nehal.

[Operator:]

Our next question comes from the line of James Anderson with R.F. Lafferty. Please proceed with your question.

[James Anderson:]

Thanks for taking my question guys and congratulations on very strong quarter. I think you mentioned on the call that a lot of the revenue growth for the first half of 2018 came in aerospace and defense and it seems like that was weighted in particular to the second quarter. I wonder if you expect this I guess an outsized growth in the aerospace and defense quarter segment relative to the other business operating segments and what the customer concentration is in that segment?

[Jeff Schlarbaum:]

Yes. So, it’s a fair question. You know the strength we're seeing in aerospace and defense work it hasn't come as a surprise. When we're out working with customers to convert new programs both new and existing on the medical front given the regulatory challenges and obstacles, the ramp to revenue timeline is longer than in the aerospace and defense and certainly in the industrial sector. I expected that those other sectors especially in the medical to catch up over time, so I don't see the aerospace and defense continuing to be – continue to grow the percentage of our revenue. I see that kind of is a – excuse me, being somewhere in that 50% or better, but not continuing to grow beyond the level that it at today. So I expect the other categories to start catching up and certainly where I see that catch-up is mostly in the medical space.

[James Anderson:]

Okay, great. Thank you. That's very helpful. And it sounds like there is something of an industry-wide component shortage as you've repeatedly mentioned. Is there a point where the component shortage will hurt your ability to grow your backlog?

[Jeff Schlarbaum:]

I mean, you know, its affecting everyone. So we're not in this alone. It's affecting the entire industry. It will affect our ability to produce all the products that our customers want when they want them. I don't anticipate that it's going to affect our ability to book new orders over time. Our customer demand seems to be fairly robust and steady. So I don't see any reason why that would be disrupted with these component constraints just mean that some of the backlog might grow at a faster rate than we can execute it for our customers, but I don't think it will hurt our bookings.

[James Anderson:]

Okay. Thanks for that. Thanks guys.

[Jeff Schlarbaum:]

Thank you.

[Operator:]

[Operator Instructions] Our next question comes from the line of Alex Gates with Clayton Partners. Please proceed with your question.

[Alex Gates:]

Hey, guys. Congrats on the great quarter. It was excellent to see the progress. You know most of my questions have actually been answered already, but I guess just thinking more broadly Jeff, do you think given where the backlog is and having some of these programs now ramp up to where they are, how sustainable do you think about this level of revenue that you guys generated in this quarter kind of going forward for the back half of this year and moving on to next year?

[Jeff Schlarbaum:]

That's a fair question, Alex. The programs that we're supporting are long-run programs. We don't see these as sort of short-term or one-time customer demand requirement. These are really longer run program awards that our customers are winning and we're winning as well. So from a sustainability standpoint I see these as building a platform for continued growth and really the fluctuations of future revenue would be associated with timing of customers requirements and/or the supply chain constraint that we've talked about, but the business that we won and that we ramped up in the course of Q2 and continued throughout the year, I think its really just foundational business that we'll build upon going over time.

[Alex Gates:]

That's excellent. And then maybe just one last question going to the three factors of growth that you outlined; one of them is from obviously existing customers where you're incrementally winning business, I would expect that the expense of other EMS companies. Maybe you can just talk a little bit about you what you're doing right and how you're incrementally winning more business?

[Jeff Schlarbaum:]

Okay. Well, this is just opinion in this area, right? It's subject to debate. But what I would tell you Alex is what we're seeing is we have a laser focus on the end markets and the type of product that we service and many of our large publicly traded competitors are much more broad-based in their focus. I mean, they service a wide variety of end market sectors. They service those customers in a wide variety of global geographies and for us we're laser focus on these mission-critical, high reliability applications in the U.S. And I think that our attention to detail and our ability to execute has been a large factor and thus being able to support our customers and as a result be the benefactor of new program awards.

[Alex Gates:]

Excellent. All right. That's it from me. And keep up the good work. Thank you.

[Jeff Schlarbaum:]

Great. Thanks, Alex. Talk you soon.

[Operator:]

Ladies and gentlemen, we have reached the end of the question and answer session. And I would like to turn the call back to Mr. Jeffrey Schlarbaum for closing remarks.

[Jeff Schlarbaum:]

Well, thank you very much. We appreciate everybody calling in. And one last think I would like to mention is that IEC will be presenting at LD Micro Conference on June the 4th in California. So we hope to see some of you there. And with that we look forward to speaking with everyone again next quarter. And thanks again for calling in.